Financial Auditing: What Is It and How to Conduct a Financial Audit?

A financial audit is a thorough examination of a company’s financial statements to ensure accuracy and compliance with accounting standards and regulatory requirements.

Internal financial audits are performed in-house to assess financial processes and risk management. There’s no regulatory aspect to an internal audit.

On the other hand, an external financial audit (also called a statutory audit) is a legal requirement, but not for all companies.

According to Section 477(1) of the Companies Act, 2006, companies in the UK are exempt from statutory audits if they qualify as small companies. Section 382(3) states that you’re a small company if you meet at least two of the following conditions:

• Turnover is not more than £10.2 million
• Total assets are not more than £5.1 million
• No more than 50 employees

Auditors look at various areas of business during an audit, including:

✅ Financial statements: Auditors review the balance sheet, income statement, and cash flow statement for accuracy and compliance with the IFRS or UK GAAP as applicable. They verify the accounting policies and whether they are applied consistently. They also verify sales records and revenue recognition policies, major expenses and their classification, and supplier and customer transactions for anomalies.

✅ Internal controls: The auditor assesses internal controls over financial reporting (ICFR) to verify that you’ve implemented effective internal controls to prevent fraud and errors.

✅ Other financial aspects: There are various other areas and transactions the auditor may want to review. This may include loans to directors, intra-group transactions, contingent liabilities, and more.

The main objective of a financial audit is to ensure compliance with the applicable accounting standards and the Companies Act 2006. There are various other reasons to conduct a financial audit, such as:

• Accuracy and reliability of financial statements

An audit verifies that financial statements are free from material misstatements. This tells you and the stakeholders that the company’s financial records accurately reflect the company’s financial health.

• Fraud detection

Audits test ICFR to identify potential weaknesses that could allow fraud or financial mismanagement. If any ineffective or inadequate controls are found, auditors dig deeper, and at the same time, you can work on improving your internal controls.

• Improve investor confidence

Investors and stakeholders make business and investment decisions based on the financial information in the financial statements. Lack of transparency or misstatements can translate to poor decisions and cause them to lose confidence in your business. Audits provide them with assurance that your reports are accurate and disclose the full breadth of available information.

• Meet contractual obligations

Audit is a legal requirement for many companies according to the Companies Act 2006. Some other contractual obligations, such as those with lenders and suppliers, may require you to undergo a financial audit as well.

Financial audits can sometimes feel like a compliance burden, but they offer various benefits. Here are the most noteworthy benefits of a financial audit:

✅ Helps identify areas of concern before it’s too late: Financial audits alarm you on time if there are risks that can turn into costly problems if not fixed. For example, auditors might highlight a failure to segregate duties in the accounting department that leaves your company vulnerable to fraud. Catching these issues and fixing them is critical to avoid financial and reputational damage.

✅ Compliance: Audits verify that your accounting records adhere to UK GAAP or IFRS as applicable. Staying compliant prevents penalties, legal disputes, and regulatory scrutiny from bodies like His Majesty’s Revenue and Customs (HMRC) or the Financial Reporting Council (FRC).

✅ Highlights opportunities to improve accounting processes: Auditors look for more than just errors. They help you identify weaknesses in internal controls, reporting structures, and bookkeeping methods, which allows you to streamline your systems and processes and improve accuracy.

✅ Boosts confidence in your company: A clean audit report tells investors, lenders, suppliers, and customers that the company is financially transparent and well-managed. This makes it easier to raise capital and build trust with stakeholders.

The process of conducting an audit depends on whether you’re opting for an internal or external audit. Here’s a general process of how a financial audit goes:

Step 1: Define Scope of Audit

You have the option to define the scope of the audit when the audit is internal. You can define what will be reviewed, the depth of the analysis, and the standards to follow. This helps keep the audit focused and quick.

While the scope of an internal audit varies significantly between industries, here are some examples of things to determine when defining the scope of the audit:

• Objective: Are you focused on operational efficiency, financial controls, tax compliance, or fraud detection
• Time period: Are you reviewing a full fiscal year or just a specific quarter?
• Departments or transactions to focus on: Are you auditing the entire business or specific areas like payroll, procurement, or revenue recognition?
• Compliance standards: What should the auditor check for—UK GAAP, IFRS, tax laws, or industry regulations
• Sampling method: Will you review all transactions or select a sample based on risk factors?

External auditors define the scope of the audit according to the law, so you don’t have the option to focus on a specific area. If you expect to undergo an external audit, just make sure you’re providing the external auditors with all the data they need. Speaking of financial data…

Step 2: Collect Necessary Data and Documents

Here are the documents the auditor needs from you:

• General ledger and trial balances
• Bank statements and reconciliations
• Invoices, receipts, and tax filings
• Payroll records and employee expenses
• Fixed asset registers
• Previous audit reports (if applicable)

They might ask for more documents as needed during the audit. Instead of scrambling to find documents last minute, it’s best to have them ready to access at all times.

Accounting software is a great way to address this problem. It gives you quick access to almost all the documents and data needed for the audit. The problem? Legacy desktop systems require the finance team to go to a specific computer or access a particular network to find documents.

Instead, use cloud accounting software like Access Financials to make your team’s job easier. When auditors ask for documents or data, your team can deliver it in seconds and without leaving the desk if you use cloud accounting software.

Step 3: Analyse Financial Data

This is where detective work begins. Your finance team acts as detectives during in-house audits. For statutory audits, you’ll need to bring in an external auditor.

Analysis in external audits is rather extensive, but here’s an overview of what it includes:

• A review of financial statements to ensure they’re complete, accurate, and aligned with UK GAAP or IFRS.
• Assessment of financial and operational risks to identify high-risk areas by looking at factors like unusual transactions, changes in accounting policies, and areas with weak internal controls.
• An evaluation of internal controls to determine whether policies and procedures are strong enough to prevent errors or fraud. This includes reviewing the segregation of duties, authorisation processes, and system security measures.
• Use of sampling techniques to select a subset of transactions and verify them against supporting documents to confirm the accuracy of transactions and the existence and valuation of assets and liabilities.
• Check compliance with UK tax laws, the Companies Act 2006, and other sector-specific laws.

Step 4: Compile an Audit Report

All the findings of an audit go into a thorough audit report along with necessary documentation.
Internal audit reports don’t have a prescribed format. They may be shorter than external audit reports if they’re narrow in scope.

On the other hand, an audit report created by an external auditor summarizes the company’s financial health, highlights errors, risks, and compliance gaps, and offers recommendations for improvement.

If everything checks out, the auditor issues a clean audit report. If not, they may provide a qualified opinion, which means some issues need fixing.

Step 5: Share the Report

The audit isn’t just for accountants. It’s used by directors, investors, lenders, and regulators to assess the transparency, accuracy, and reliability of your financial reports.

Make sure the findings are presented in plain English, not just numbers, so stakeholders understand what went well, any red flags, and how the company should improve financial controls moving forward.

If the external auditor provides a qualified opinion in the audit report, it tells the stakeholders that the auditor found a problem or was unable to reasonably verify a transaction or line item or that the company failed to follow the applicable accounting standards.

Following a qualified opinion, you must provide stakeholders with a justification, correct the problem, and prepare a follow-up auditor report in case of more serious issues.

Preparing for challenges and limitations of the audit process before starting can help minimize their impact. Here’s what you need to be mindful of:

Missing or Inaccurate Financial Data

Data and accurate records are the most critical assets for an auditor. Missing invoices, incomplete ledgers, or discrepancies in financial statements can make the audit process painfully slow and expensive. Missing or inaccurate data typically results from:

• Poor record-keeping: This is especially a problem in smaller businesses that lack dedicated finance teams and don’t use accounting software.
• Data silos: Incomplete data is reported by other departments, often because they’re not aware of the importance of reporting accurate financial data.
• Fraud or intentional misstatements: These make it harder for auditors to verify financial accuracy because they’re carefully planned. Further investigation is necessary, so fixing the first problem on the list and maintaining complete financial records is crucial.

Accounting software can address all of these problems. It makes managing financial records easier, allows all teams to report financial data with minimal effort, and makes financial information easily and securely accessible when needed during an audit.

Lack of Internal (and External) Resources

Audits require extensive preparation. If your finance team is already stretched thin, you might face the following challenges:

• Operational slowdowns: Key finance staff might need to be pulled away from strategic tasks to gather audit documentation.
• Increased risk of errors: For example, understaffed teams may rush reconciliations, which can lead to misstatements that auditors flag.
• Delayed audits: If auditors struggle to get timely responses from your team, the audit process drags on, creating compliance risks and disappointing top-level stakeholders.

Error-Prone Manual Processes

If you still rely on spreadsheets and manual data entry, you’re asking for trouble. Human errors like typos, transposed numbers, or missed entries can lead to:

• Financial misstatements: Even if unintentional, financial misstatements trigger audit qualifications.
• Increased risk of fraud: Manual processes are harder to track and control. Even if you detect the fraud, finding the person responsible for it may be challenging.
• Wasted time: Auditors may have to sift through and verify inconsistent records, making the audit process unnecessarily tedious and expensive.

Accounting Software Limitations

Legacy, on-premise systems can create more problems than they solve. They don’t offer real-time visibility over data and require employees to manually generate and reconcile accounts.

Most modern businesses have switched to cloud-based accounting software like Access Financials that offers:

• Accurate, instant financial insights: Helps track cash flow, expenses, profitability, and more.
• Better accuracy and compliance: Built-in automation that minimizes errors and speeds up the audit process.
• Secure access from anywhere: Finance teams and auditors can review financials regardless of their location and device, provided they have the correct access permissions.